Reserve Bank releases consultation paper on Basel III reforms

​The Reserve Bank of New Zealand wants submissions by 27 January 2012 on its proposals to implement the core Basel III measures regarding capital ratios, the definition of capital and the leverage ratio.

The RBNZ has joined its Australian counterpart, APRA, in fast-tracking the new regime.

This Brief Counsel looks at the proposed changes.

Accelerated implementation

Both the RBNZ and APRA propose to implement the replacement capital adequacy regime on 1 January 2013. This is in contrast to the phased approach envisaged by the Basel Committee. Under Basel III, for example, the common equity tier 1 requirement is not fully implemented until 2015.

The accelerated timetable proposed by APRA and the RBNZ reflects the relative strength of the Australasian banking system.

New capital ratios

Under the new capital ratio requirements; the banks will be required to hold a minimum tier 1 capital of 6.0% (up from 4.0%), of which 4.5% will need to be “core” common equity, and a total capital of 8.0% (as is currently the case). In addition, banks will need to have a common equity conservation buffer of 2.5%, effectively requiring a total capital of 10.5%.

If the country goes through a period of excess credit growth, the RBNZ may also require banks to have a counter-cyclical buffer (varying from zero to 2.5% of common equity) which would be added to the conservation buffer.

The distinction between upper tier 2 capital and lower tier 2 capital will be dispensed with.

Affected New Zealand banks should have no great difficulty in meeting the accelerated timetable as most already have regulatory capital well in excess of the core requirements. In the current environment of de-leveraging (at least in the non-government sector), there is little prospect of a macro-prudential conservation buffer being required in the near term.

Tier 1 capital instruments

Broadly the RBNZ is proposing to adopt the “core” common equity tier 1 capital requirements subject to several technical exceptions. This will result in a slight tightening of the existing criteria for “core” tier 1 instruments.

In relation to the “additional” tier 1 capital requirements, the RBNZ intends to limit the types of instruments that can be issued to meet these criteria to perpetual non-cumulative preference shares (reflecting the current position), rather than allowing for a broader range of instruments as permitted under Basel reforms.

This will mean that aspects of the new Basel criteria will not be applicable. The RBNZ will also continue with its requirement that perpetual non-cumulative preference shares which do not have full voting rights cannot comprise more than 25% of the overall tier 1 capital.

Tier 2 capital instruments

Similarly, the RBNZ is proposing to implement the Basel requirements in relation to tier 2 capital subject to several technical exceptions. This will result in a tightening of the qualification criteria, particularly for existing tier 2 capital instruments.

Further consultation

At this stage the RBNZ is asking for comments on the new measures in respect of capital ratios (i.e. tier 1 and tier 2) only. Next year it intends to consult on the other Basel requirements covering:

the conservation and counter-cyclical buffers

the counterparty credit risk requirements, and

potential additional disclosures.

Significantly, the RBNZ has confirmed that it is not proposing to implement the “non-risk” based leverage ratio requirement - which would have banks needing to meet a 3% tier 1 capital threshold on a “non-risk” base analysis. In this regard, it has parted company with APRA, explaining that the leverage ratio is “poorly targeted and can give a misleading picture of risk”. It is yet to be seen whether the benefits of international harmonisation are viewed as outweighing the costs of this clumsy new Basel requirement.

Implications

The Basel proposals come hard on the heels of the home-grown “open bank resolution” (OBR) policy and the pre-positioning required to implement that policy.

Although, as noted, the capital side of Basel III may present few challenges to the major domestic banks, the broader implications will take some working through. The new “credit value adjustments” that will be required to bring counterparty risk into the capital equation may have broad impacts on how derivatives and other markets activities are undertaken. This is also going to be a world where custody and liquid assets are all-important – something potentially made much more challenging by the erosion of faith in government credit. This may well be an area where the fine print carries more significance than the headlines.

It is the macroeconomic implications of the framework that are currently generating the most debate internationally. There is a view that the costs of the regime to bank profitability and aggregate growth will, over the medium term, be for the most part neutralised by the benefits of reducing the risks of another financial crisis, and the massive economic damage wrought by that.

This view, however, is being broadly challenged as there are significant methodological issues with the macroeconomic studies and a wide variance of results in relation to the spread and GDP cost of the measures. The Basel working party assessed the cost in terms of spread as 34 basis points and in terms of reduction in GDP as 0.35% pa. On the other side of the coin, the purported GDP benefits in the form of the decline in the probability or frequency of financial crises seem heroic – growth of between 1.98% and 2.10% of GDP per year according to the working party.

On the home front, the capital regimes applying to the finance company and insurance industries will also need to be borne in mind when assessing macroeconomic impacts. Both these regimes are also in the formative stages, with the Insurance (Prudential Supervision) Act 2010 soon to be implemented and the new Non-Bank Deposit Takers Bill due to be picked up by the legislature in the New Year.

Further Brief Counsels

Chapman Tripp will continue to track developments around Basel III and capital requirements more generally and will produce further Brief Counsels on these issues as appropriate.